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e process of winding up a business normally consists of the conversion of a portion or all of the

assets into cash, settlement with creditors, and the distribution of remaining assets to the partners.

e conversion of assets into cash is referred to as realization. e payment of liabilities is referred to

as liquidation; however, it is also used in a broader sense to refer to the complete winding up process.

Procedure in Liquidation

When a partnership is to be liquidated, the books should be adjusted and closed and the net income or loss for the period should be carried to the partners’ capital accounts. e partnership is then ready to proceed with liquidation.

As assets are converted into cash, any dierences between the book values and the amounts realized represent gains or losses to be divided among partners in the pro t and loss ratio. Such gains and losses are carried to the capital accounts, which will become the basis for settlement.

In the course of liquidation, when a partner’s capital account reports a debit balance and such partner

has a loan balance, the law permits exercise of the right of oset, that is, the oset of a part or the entire loan against the capital de ciency. A debit balance in the capital account in the absence of a loan balance or aer oset of a loan balance indicates the need for a contribution by the de cient partner.

e inability of a partnership to recover a capital de ciency will mean the remaining partners will have

to absorb such amount.

As cash becomes available for distribution, it is rst applied to the payment of outside creditors. It may then be applied in settlement of partner’s loan and capital balances. It may be observed that the Philippine Partnership Law provides that partners’ loan shall rank ahead of partners’ capital in order of payment.

Procedure in summarized form:

1. Realization of assets and distribution of gain or loss on realization among the partners based on the pro t and loss ratio.

2. Payments of expenses – During the liquidation process, expenses are usually incurred, such as legal and accounting expenses and advertising cost of selling the assets. e expenses are allocated to partners’ capital accounts in their pro t and loss ratio.

3. Payment of liabilities

4. Elimination of partner’s capital de ciencies. If aer the distribution of loss on realization, a partner incurs a capital de ciency (i.e., partner’s share of realization loss exceeds his capital

credit), this de ciency must be eliminated by using one of the following methods, in the order of priority.

a. If the de cient partner has a loan balance, exercise the right of oset.

b. If the de cient partner is solvent, make him invest cash to eliminate his de ciency.